Sensex rallies but government bonds face the rate change heat

Sensex rallies but government bonds face the rate change heat
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First Published: Thu, Jun 26 2008. 12 08 AM IST

Anxious moments: An onlooker gestures as he watches share prices on a screen on the facade of the Bombay Stock Exchange on Wednesday. (Photograph by Gautam Singh/ AP)
Anxious moments: An onlooker gestures as he watches share prices on a screen on the facade of the Bombay Stock Exchange on Wednesday. (Photograph by Gautam Singh/ AP)
Mumbai: India’s most tracked stock indices, the Sensex and Nifty, had a relief rally and the rupee rose but government bonds fell on Wednesday, a day after the central bank raised its key policy rate and took more cash out of the banking system in its war against inflation.
Anxious moments: An onlooker gestures as he watches share prices on a screen on the facade of the Bombay Stock Exchange on Wednesday. (Photograph by Gautam Singh/ AP)
The Bombay Stock Exchange’s (BSE’s) benchmark Sensex gained about 113 points, or 0.8%, to 14,220.07, after losing about 375 points during the day’s trading. The Sensex had lost some 10% in five previous sessions. The broader 50-stock Nifty index gained 1.4%.
But the stock rally may prove short-lived, according to analysts who say there is still some downside left for the indices.
The Reserve Bank of India (RBI) on Tuesday raised its short-term lending rate and the amount of cash that commercial lenders are required to park with the central bank as a proportion of deposits by half a percentage point each in a counter-attack against inflation, which is at a 13-year high.
The Sensex lost 1.3% on Tuesday and slipped below the psychological 14,000-point level on heavy selling as traders anticipated the policy action announced late in the evening.
Analysts said the recovery was largely because of short-covering, or the purchase of shares previously sold short in order to close an open position. Strong gains across key Asian and European markets also boosted sentiment.
Both RBI and the government have made the fight against inflation, which this month crossed 11%, their top priority. RBI on 11 June raised the key lending rate by a quarter of a percentage point. It has sucked money out of the financial system by raising banks’ cash reserve ratio.
Surging inflation on the back of rising fuel and food prices and the policy moves have devastated investor sentiment. The monetary tightening will make credit more expensive for companies and consumers. “The fire-fighting to contain current economic headwinds may end up worsening inflation and hurting growth in the longer term,” said Sachchidanand Shukla, an economist at Mumbai-based financial services firm Enam Ficancial Consultants Ltd.
The India strategy report this week by US-investment bank Morgan Stanley, warns of a potential downside of 30% for the Sensex, with the risks of earnings downgrades and rising long-bond yields.
In a worst-case scenario of economic growth slowing and bond yields rising, the fair-value of Sensex could be around 10,000, the report said. Since reaching its peak in January, the Sensex has already lost more than 32%.
Not everyone is bearish on the market. Nilesh Shah, chief executive of Ambit Capital Pvt Ltd, a domestic brokerage, says the Sensex will gain in the short term..
“There could be around 10% bounce-back from current levels,” he said. However, interest-rate sensitive sectors such as automobiles and real estate will underperform the broader market, he added.
Rupee rally
The local currency rallied by about 20 paise on Wednesday and closed at 42.73/74 to a dollar against its Tuesday’s close of 42.9625/9700.
Exporters, who had largely been staying away from the market for the last couple of weeks, were seen selling dollars. RBI, which has seen selling dollars through a clutch of state-run banks to prevent the rupee breaching the 43 level, stayed away from the market.
A stronger rupee also helps combat inflation by making imports cheaper.
“There is a strong chance that the sentiment will remain bullish in the foreign exchange market. The rupee might touch 42.50 a dollar this week or within ten days,” said a dealer with a foreign bank who did not wish to be named, citing company policy.
“RBI wants a strong rupee to fight the inflation. Following the rate hike, the sentiment has changed in the currency market,” said a senior dealer with a public sector bank who also did not wish to be identified and forecast the rate to reach 42.50.
Bond prices fell, with the yield on the 10-year benchmark bond closing higher at 8.62% from its Tuesday’s close of 8.57%. Bond yields and prices move in opposite direction.“The hike in policy rate as well as CRR (cash reserve ratio) was already discounted but the severity of the hikes was not anticipated,” said S.S. Raghavan, head of treasury at IDBI Gilts Ltd, a primary dealer.
“Bond yield will still track the inflation numbers that come on Friday and could stabilize at 8.70-8.80% in the coming days,” he said.
Kotak Mahindra Bank Ltd, in a research note, said it expects the 10-year benchmark yield to trade in the region of 8.75 to 9.50% in the “medium-term.” With monetary policy uncertainties having increased, the outlook for the bond market may change, it said.
RBI will meet for a quarterly review of monetary policy on 29 July but it isn’t clear yet whether the central bank will need to resort to more tightening. The inflation holds the key to the course it adopts.
nesil.s@livemint.com
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First Published: Thu, Jun 26 2008. 12 08 AM IST
More Topics: Sensex | Rupee | Government | Bonds | Nifty |